When we think of taxes we think of the government or bank robbing our money to fund its own projects while also increasing the national debt.
Yes, that is partly why taxes exist but more broadly, taxes are found practically everywhere, from your real estate to the purchases that you make daily at the store. They are simply fees that are non-negotiable in order to fund government activities such as bettering the economy, aiding the military, providing stimulus to the rest of the country, repairing our country’s streets and infrastructure, etc.
Unless you are the president who according to the NY Times paid only $750 and supposedly is participating in tax evasion, who is constantly touting that he is being audited (briefed over by an accountant) for the past 3 years, you have to pay your taxes fair square.
There are many types of taxes you will pay throughout your lifetime and the money you are taxed on could be income earned from your salary, capital gains from investment appreciation, dividends from stocks in your portfolio and even the payment of purchasing a good.
Essentially, the older you get the more you buy and own which means more money you pay in taxes that go into Uncle Sam’s pockets.
These are the main types of taxes:
Income Tax: A percentage of individual earnings filed to the federal government
Depending on taxpayer’s filing status such as: Married filing jointly single, head of household, etc.
Corporate Tax: A percentage of corporate profits taken as tax by the government to fund federal programs.
Capital Gains Tax: Taxes on income that results from the sale of assets in which the sale price was higher than the purchasing price-ex. Selling a home
There are 2 types of capital gains:
Short-term capital gains and long-term capital gains.
Short-term capital gains result from an asset you sold after owning it for less than one year. They are taxed the same way as your usual taxes, using the tax brackets relevant to your filing status as if the gains were regular income.
Long-term capital gains result from an asset you sold after owning it for more than one year. Using a different set of tax brackets, the IRS taxes these net capital gains at much more favorable rates than ordinary income.
Capital Losses:
Capital losses occur when you sell an asset for less than you paid for it.
You can deduct up to $3,000 of a capital loss per year (or $1,500 if your filing status is married filing separately) from your taxable income. If a capital loss exceeds the $3,000 deduction, you can carry over the excess amount and deduct it the next year, and so on until you’ve deducted the full amount of the capital loss.
Dividends:
Dividends are payments companies make to their shareholders. Even if you own just a little bit of stock, you may be paid a dividend. Dividends are taxed at the same rate as short-term capital gains and remember, you have to pay taxes whenever you sell a stock.
Heavenly Bonuses:
Yes, these are even taxed and no different than your ordinary income. I recommend stashing your extra income into a high-yield saving account for a rainy-day fund or emergency instead of having it earn $1 in a savings account per year which is just sad.
Sales Tax: Taxes levied on certain goods and services(everyday items, doesn’t change for the individual)
Why Do The Rich Pay Less in Sales Tax?
Because a tax on coke is the same for a poor or rich man but in essence $5 a bottle is a smaller portion out of their net worth than a poorer individual.
Healthcare and education is also cheaper for the rich.
Property Tax: Based on the value of land and property assets
Depending on where you live you could pay upwards of 13.3% of taxes living in California or 11% in New Jersey.
New York has the highest tax burden of any state with residents spending 13.8% of their annual income on state and local taxes which is nearly $1,700 higher than the national average.
Americans pay just over $5,000 a year in state and local taxes, equal to 9.8% of their estimated annual income.
Typically, property taxes are the largest driver of the overall tax burden within a state.
Tariff: Taxes on imported goods imposed with the aim of strengthening internal businesses
Estate Tax: Rate applied to the fair market value of property in a person’s estate at the time of death
DIFFERENT THAN PROPERTY TAXES!
Now since we’ve covered the most common types of taxes, let’s dive into how they are allocated.
Taxes are imposed at federal, state, and local levels.
The Federal Government levies:
-Income
-Corporate
-Payroll taxes
-Social security
-Medicare
-Capital gains
State Levy:
-Sales tax
Municipalities/Local Governments Levy:
-Property taxes
What Determines the Tax Rate?
The IRA uses a series of ranges that represent increasingly higher amounts of income called tax brackets.
For every dollar you make, you fall into each bracket and owe a certain percentage of income.
Biden is proposing to charge wealthier taxes for the 1% as they hold 80% of the wealth in this country which will allow the government to increase its spending to help our country.
Who Does Our Taxes?
Tax planning can seem daunting but in fact, since all of us do it and want the best rates, it is helpful to start earlier than later and really isn’t complicated if you use time as your trusty friend.
According to the IRS (Internal Revenue Service), it is best to start organizing and planning for next year’s taxes on April 15th,n exactly a year before so you can save your time and money.
And yes, the IRS will never call you don’t fall for the most popular scam!
Quick Steps To Start Filing:
- Organize documents: Maintain records of all transactions and receipts that affect your tax return
- Recent Life Updates/Actions: Did anything change? Did you get married or give birth/adopt a child? If so, you need to file a new Form W-4
- Shop For An Advisor: Someone who will prepare your taxes for you, similarly to an accountant to get you the best deal with your taxes and help you file them legitimately so you don’t have to pay fines if you get audited
- Keep Important Records in Check: Establish 1 location in your home, preferably in a safe or vanilla folder where you have tax-related records during the year. For example, you may need a copy of your tax return if you apply for a home loan or financial assistance for college.
Important documents to have each year:
- W-2
- W-4
- Form 1099
- Bank records
- Health Care Insurance Coverage Records
Forms, Forms, and More Forms
The forms: W2 Vs. Form 1099 are the main forms you need to focus on as an employee and contractor a.k.a self-employed.
When you are self-employed you DO NOT file your taxes annually, they are done quarterly.
Self-employed, you do not withhold takes from paychecks since you pay your own taxes and provide your own benefits.
Form 1099: Used to report payments made to self employers
W-2: Used for employees whose employer withholds payroll taxes from their earnings
Additional Tax for Employers:
Payroll taxes:
These are the taxes paid on the wages and salaries of employees and are used to finance social insurance programs such as Social Security and Medicare.
If you’ve heard of FICA and MEDICA this is where they come into play.
These social insurance taxes make up 23.05% of combined federal, state, and local government revenue.
This is the second-largest source of government revenue in the US along with state income tax.
So who pays for these taxes?
Rather than workers and employers each paying 7.65 percent in payroll taxes, employers send their portion of the tax to the government and then decrease workers’ wages by almost 7.65 percent. Workers pay their 7.65 percent share on those wages.
Help?!
So how do you handle all of this to make sure you aren’t penalized and put into jail?
Even though you aren’t worried since our president isn’t nervous even though he most likely committed a crime, it’s always good to be safe than sorry.
It is highly suggested to develop a strategy that with a tax advisor/accountant who will help you file your tax returns or else you will have to know the ins and outs of dealing with this tedious paperwork before tax day each year on April 15.
Accountant/Advisor Cost
Well, since you need to collect all the paperwork for them to file which includes your receipts, tax write-offs, business expenses, etc. they charge anywhere from $50 to $300 an hour but typically only for a few times per year you meet.
How to Pay Less in Taxes
Tax Deductions:
The most common ways to lower your taxes is by owning a home, getting married, paying off medical expenses, and making qualified donations to charity.
As stated in the word, deductions mean anything that is written off that you can eliminate paying taxes on.
The 2017 Tax Cuts and Jobs Act (TCJA) eliminated several self-employed tax deductions and this law affects small businesses in particular.
Some deductions include:
-Entertainment deductions
-Employees’ parking, mass transit, commuting expenses
Self-Employment Tax:
As a self-employed worker, you can make massive deductions on virtually anything you claim to be part of your business.
From a client dinner to that new suit, you write it as a business expense and won’t need to pay taxes. And a business could mean having tenants in your rental property to your YouTube channel or blog. it doesn’t need to be physical or have employees working for you.
In addition, your health insurance premiums, internet, and phone bills, office, gas to your office can all be written off!
Tax Deduction Tip!
Use an IRA instead of a savings account. Many taxpayers put their savings into a typical bank account that earns tax interest! By avoiding paying tax on the interest each year, deposit the money into a traditional IRA where the interest will accumulate tax-free
529C-imilarity
This is similar to the deductions that you can take from a 529C plan, a college savings plan.
This plan offers unsurpassed income breaks meaning that the money inside the plan will grow federal tax-free and NOT BE taxed when taken out for college-related expenses.
It is pre-taxed money meaning that your parents paid taxes on it before they invested it in there.
401(K) vs. IRA
Both of these accounts have valuable tax benefits and can be contributed at the same time.
They both relate to saving for retirement part of your income.
With investing, the earlier you start the better.
Time = Money.
Main Difference:
401(k):
Employers (companies) offer to contribute a portion of your salary directly into saving for retirement
- Pro: Offer more investment types a.k.a diversification
- Con: Hefty Adminstration fees
Some companies offer matches, for example, some employers promise a 100% match up to 3% of salary.
That means, if your salary is $50,000, your employer will put in $1,500, as long as you also contribute at least $1,500. Once you get the match, then consider maxing out an IRA for the year, return to the 401(k) and resume contributions there.
No Match:
Consider skipping the 401(k) and go with the IRA or ROTH IRA (a compounding machine).
IRAs:
Using brokers or banks-individually, if you are self-employed or don’t work for a large corporation/firm
- Pro: Allow higher annual contributions, no fee
So where do I create an IRA or ROTH IRA?
Best ranked providers in 2020:
- Fidelity
- SOFI
- Betterment
- Vanguard
- Charles Swab
They all come with their pros and cons.
Some have fees and minimums per year and others have an account minimum.
It is up to you on how much you want to spend and what institution you trust.
Tax Implications:
401(k):
- Accepts pre-tax dollars meaning your contributions are taken from your paycheck BEFORE taxes are deducted.
So if you have a lower amount of income and contribute most of it to this account, you don’t have to pay as much in taxes on what you are making now.
IRA:
- Accepts post-tax/after-tax contributions meaning you DO Not pay income tax on the money you contribute each year, only when withdrawing
Since this is the case, I would suggest keeping a good amount of your income on the sidelines to invest, use as passive income instead of investing fully into your retirement account since as grandma or grandpa, you have to pay hefty fines on that money depending on what the tax rate is when you are withdrawing and using it.
I hope this clarified everything you need to know about taxes and how you can become more confident about starting your fantastic tax journey.
Okay, it’s not that fun but why not since you have to do it anyway!